Leading economic indicators explained: what they signal

A leading economic indicator is a data series that tends to change direction before the broader economy does. Analysts use leading indicators to look for early signs of a turning point in the business cycle, in contrast to reports such as GDP or the jobs report, which describe activity that has already happened. The best known composite is the Leading Economic Index published by The Conference Board.

In brief

• Indicators are grouped by timing: leading, coincident and lagging.
• The Conference Board’s Leading Economic Index combines ten components into one composite.
• Leading indicators raise probabilities. They do not predict outcomes with certainty.
• Most components come from public government sources and are on the economic calendar.

Leading, coincident and lagging

Economists classify data by how a series moves relative to the business cycle.

• Leading indicators turn before the economy turns. New orders and building permits are standard examples because they reflect decisions made before output changes.
• Coincident indicators move with the economy. Payroll employment and industrial production are typical.
• Lagging indicators change after the economy has already turned. Unemployment duration and some labor costs fall in this group.

The Conference Board publishes all three types as a system. Its description of the Leading Economic Index places it alongside a Coincident Economic Index (CEI) and a Lagging Economic Index (LAG). Reading the three together helps place a development in context: leading data rolling over while coincident data are still firm is a different situation from all three weakening at once.

The Leading Economic Index

The Conference Board describes the US Leading Economic Index (LEI) as a composite index meant to signal peaks and troughs in the business cycle about seven months ahead of time. It is published monthly. Each release includes a press release, a longer version with graphs and summary tables, and technical notes. The index is expressed relative to a base year of 2016, which is set equal to 100.

The ten components

The Conference Board lists these ten components:

1. Average weekly hours in manufacturing
2. Average weekly initial claims for unemployment insurance
3. Manufacturers’ new orders for consumer goods and materials
4. ISM Index of New Orders
5. Manufacturers’ new orders for nondefense capital goods excluding aircraft orders
6. Building permits for new private housing units
7. S&P 500 Index of stock prices
8. Leading Credit Index
9. Interest rate spread (10-year Treasury bonds less the federal funds rate)
10. Average consumer expectations for business conditions

Several of the ten come from government releases that appear on the economic calendar. Weekly hours in manufacturing come from the Bureau of Labor Statistics’ employment survey. Initial unemployment claims are published weekly by the Department of Labor. Orders and permits come from Census Bureau economic indicators. The interest rate spread uses Treasury yields and the federal funds rate, and the stock price component uses a market index. The ISM index and the consumer expectations measure are survey-based, produced by private organizations.

Why these components lead

Each component has a plausible link to later activity.

• Hours and claims. Employers typically trim hours before they cut staff, and initial claims reflect layoffs as they begin.
• New orders. Orders for goods precede production and shipments.
• Building permits. Permits are issued before construction starts.
• Stock prices. Equity markets embed expectations about future earnings.
• Credit conditions. Tight credit tends to precede weaker spending and investment.
• The yield spread. The gap between long-term Treasury yields and the short-term policy rate has historically been associated with the direction of the economy, because it reflects expectations about monetary policy and growth.
• Consumer expectations. Households and businesses that expect worse conditions adjust spending plans.

These are relationships observed over many cycles. They are tendencies, not mechanical rules.

How the index is interpreted

Direction and persistence

A single monthly change in the LEI carries little information on its own, because the index is built from noisy components. Analysts therefore look at its direction over several months and at how many components are contributing positively. The Conference Board publishes a diffusion measure for this purpose, which shows the share of components that are rising.

The recession signal

The Conference Board describes a “3Ds” rule for recession signals, which weighs depth, duration and diffusion. According to its description, a signal is triggered when the six-month diffusion index is at or below 50 and the LEI’s six-month growth rate, annualized, falls below minus 4.3 percent. Treat this as one organization’s rule of thumb. It is not an official designation, and it can issue false signals or lag in practice.

In the United States, the official dating of business-cycle peaks and troughs is made by the National Bureau of Economic Research, not by any index.

Other indicators to know

Beyond the composite, many individual series have a following.

• Purchasing managers’ and ISM surveys. These ask firms about new orders, production and employment.
• Weekly jobless claims. The most frequent labor-market signal.
• Housing starts and permits. Census releases that reflect the housing cycle.
• Consumer confidence and sentiment. Survey measures of household outlook.
• Yield-curve measures. Spreads between Treasury maturities.
• Credit spreads and lending surveys. Gauges of how freely credit is available.

None of these is a forecast on its own. They are inputs.

How leading indicators fit with the headline reports

The data that most people think of as “the economy” are mainly coincident or lagging. The GDP report, described in our guide to how GDP is measured, reports output after the quarter has ended and is estimated three times as more data arrive. The jobs report, described in how the jobs report works, measures employment in a reference week and is revised afterward. Leading indicators try to fill the gap before those reports confirm a trend.

The two uses complement each other. A reader who sees leading indicators weaken can watch coincident data for confirmation. A reader who sees coincident data soften can check whether leading data had signaled it.

How the composite is built

A composite index combines its components so that no single volatile series dominates. The Conference Board standardizes the components, weights them and links them into one index that is expressed relative to its 2016 base year. Readers do not need the arithmetic to use the result, but two consequences are worth knowing. First, the composite can rise even when some components fall, because the others offset them, so the breadth of the move matters. Second, because the stock price and interest-rate components respond immediately to markets, the LEI can react to financial conditions faster than it reacts to the slower-moving orders and permits data. The Conference Board’s technical notes document the method and any changes to it.

Limits and cautions

• False signals. Leading indicators have sometimes weakened without a recession following.
• Variable lead time. The Conference Board describes a lead of about seven months, but actual lead times vary from cycle to cycle.
• Revisions. Components are revised, and so is the composite.
• Changing structure. The economy changes. A component that worked well in earlier decades may carry a different weight today, which is why the Conference Board periodically reviews its method.
• Market-based components. Stock prices and credit conditions respond to news and policy as well as to the economic outlook.
• Not a market timing tool. This guide is about understanding the data. Nothing here is investment advice.

A worked example of reading the signals

Imagine a reader who notices three things in a given month: manufacturers’ new orders are soft, initial claims are edging higher and building permits have declined. Each is a leading series. The reader would then check the coincident data: is payroll employment still growing, and is production holding up? If those remain firm, the leading data have not yet been confirmed. The reader would also look at the Conference Board’s diffusion measure to see whether weakness is broad or confined to one or two components. This sequence, leading first, coincident for confirmation, and a check on breadth, is the standard way to use the data without overreading any single release.

FAQ

What is the most widely cited leading indicator?

The Conference Board’s Leading Economic Index is the best-known composite for the United States. It combines ten components and is published monthly.

How far ahead do leading indicators look?

The Conference Board describes the LEI as signaling turning points about seven months ahead. Individual series have different lead times, and the relationship varies by cycle.

Is the yield curve a leading indicator?

The spread between the 10-year Treasury yield and the federal funds rate is one of the ten LEI components. Other yield-curve measures are also followed, though none is a certain predictor.

Can leading indicators predict a recession?

They can raise or lower the probability. They have given false signals and have sometimes lagged turning points, and official recession dating is done by the National Bureau of Economic Research.

Where do I find the release dates?

The Conference Board posts its release schedule on its LEI page. Government components follow the BLS, Census Bureau and Department of Labor calendars.

Are leading indicators the same as forecasts?

No. A forecast is a projection of a future value. A leading indicator is an observed series that has tended to move earlier than the economy.